Enforcing Unwritten Founder Sweat Equity Claims During Down Round Restructurings
Unwritten sweat equity claims convert to low-priority common claims during down rounds, facing total elimination beneath senior liquidation preferences.
dilution waterfall
Meaning
Financial models calculate the proportional reduction in share ownership as subsequent funding rounds or option exercises occur. The dilution waterfall shows exactly how the ownership of each shareholder changes when new capital enters the company or when the employee option pool expands. It maps out the cascading effect of these changes across all share classes.
This tool is essential for understanding the long-term value of equity in various exit scenarios.
Capital Flow
Mathematical projections demonstrate the impact of price per share on the final ownership percentages. The dilution waterfall tracks the movement of equity from founders to new investors. Every new issuance creates a downward pressure on the percentage of the company owned by the original team.
These calculations help founders negotiate the terms of a new investment by highlighting the trade-offs between capital infusion and ownership loss.
Exit Distribution
Analysis of the payoff at different valuation levels reveals the actual returns for each class of stock. The dilution waterfall calculates the proceeds available to common and preferred shareholders after the liquidation preferences are satisfied. This process ensures that everyone knows their place in the hierarchy of payment.
Sequential Logic
Precise ordering of events prevents errors in the calculation. The dilution waterfall follows a step-by-step approach to equity reduction.